Strategy and Outlook for a 'Prove it to Me' Market

S&P 500 Support Study & Asset Class Analysis

Despite the impressive rally off the S&P 500's lows on Tuesday, the bears
and fear still control the markets from a short-term perspective. Considering
market participants were already concerned about the winding down of QE2 before
the events in Japan, it is prudent from a planning and risk-management perspective
to gain a better understanding of:

How long should we remain defensive?

Where should we redeploy our cash?

How far could stocks fall?

Where does support exist?

How strong is that support?

From a fundamental perspective, the news from Japan and ongoing reaction to
the Fed will most likely carry over into Wednesday's trading session. The Fed's
statement neither hinted at QE3, nor did they close the door relative to expanding
QE2. The text related to their current bond purchase program:

To promote a stronger pace of economic recovery and to help ensure that
inflation, over time, is at levels consistent with its mandate, the Committee
decided today to continue expanding its holdings of securities as announced
in November. In particular, the Committee is maintaining its existing policy
of reinvesting principal payments from its securities holdings and intends
to purchase $600 billion of longer-term Treasury securities by the end
of the second quarter of 2011. The Committee will regularly review the
pace of its securities purchases and the overall size of the asset-purchase
program in light of incoming information and will adjust the program as
needed to best foster maximum employment and price stability.

The part that reads "...and will adjust the program as needed..." could be
interpreted as either a contraction or expansion of the current $600 billion
target. The S&P 500 was trading at 1,277 when the Fed's statement was released.
Given the close of 1,282, it is difficult to interpret the market's short-term
reaction as bullish; neutral would probably be a better short-term classification. In
terms of our approach to the markets, we need to get a better read on the reaction
to the Fed's statement, which should come by mid-day on Wednesday.

According to reports a new fire has been reported in the No. 4 reactor in
the damaged nuclear complex in Japan. In the last 24 hours, aftershocks of
5.7 and 6.1 magnitudes have kept citizens and officials on edge. Add in people
without homes, homes without power, and freezing temperatures and you have
conditions in Japan that may continue to negatively impact asset prices. However,
the Asian markets were able to post gains in mid-morning trading on Wednesday.
Obviously, changes for the better or additional negative developments in Japan
need to be monitored since they will impact the short-to-intermediate-term
tone of the markets. As long as nuclear uncertainty exists in its present
form, we will err on the side of holding cash and buying in limited quantities
should the market show some improvement.

To help us monitor the market's take on the Fed and Japan, while addressing
the question of how long should we stay defensive, we will use the technical
checklist below as a forced disciplined tool. We first presented the table
below using data from March
7, 2011, which helped us remain patient with our cash over the last ten
days.

The basic concepts in the table above can be summed up as follows:

In the short-run, until the market can prove otherwise, we will continue
to give the bears the benefit of the doubt since they have control of the
very short-term trends. Big-picture-wise and longer-term, we will give the
bulls and the bull market the benefit of the doubt, until proven otherwise,
since they control the long-and-intermediate-term trends. We refer to the
current market as a "prove it to me" market.

Assuming the conditions above are met and we are more comfortable with Japan
and the reaction to the Fed, the next question on the docket is where to redeploy
our cash. As we mentioned yesterday,
we still believe the market's perception of where the Fed is headed with quantitative
easing is important relative to what to buy. When the majority or all of
the conditions in the technical table above are satisfied, we will consider
the inflation-friendly assets on the right side of the table below and on the
right side of yesterday's table. Should the current correction morph into something
looking more like a topping process, we will consider the defensive assets
on the left side of the table below and on the left side of yesterday's
table.

Yesterday, we showed the top 18 performers. The table below shows those
ranked 19 through 28 since we may want to look a little deeper into a browsing
list of possible buy candidates.

Fundamentally, the results in the table above make intuitive sense with more
conservative and stable earners, such as telecom (IYZ) and consumer staples
(XLP), appearing on the left and more cyclical earners, such as retail (XRT),
technology (FDN), mid-caps (MDY), and materials (IYM, XLB), appearing on the
right. Since the S&P 500 has corrected over 6% from the recent highs to
the recent lows, we are more open to redeploying some cash if we get some evidence
of a possible turn in stocks.

We need more information from Japan and the markets before we can choose to
focus on defensive or inflationary assets. For now we will hold our longs and
a relatively large cash position that we have accumulated over the last few
weeks. Based on the incremental
approach, we did some limited selling yesterday, cutting back on gold
stocks (GDX), Australia (EWA), Germany (EWG), and inverse Treasury bonds (TBT).

Numerous economic reports, which may impact our thinking, are due to be released
this week, including inflation (CPI), weekly jobless claims, industrial production,
leading indicators, the Philly Fed survey, and an update on the Fed's balance
sheet.

We have addressed the first two questions posed at the top of the article.
We will now turn our attention to trying to better understand:

How far could stocks fall?

Where does support exist?

How strong is that support?

Before we move to the table below, it may be helpful from a confidence and
usefulness perspective to check back on a recent support and resistance study.
On January
7, 2011, we presented a summary table that highlighted 1,316 and 1,326
as probable areas where stocks could run into some trouble. We also listed
1,292 and 1,298 as possible areas where sellers may become more active. The
market was only able to stay above 1,326 for four trading days before sellers
took over. The term 'probable' is used above as a way to acknowledge in advance
that both support and resistance can be broken and/or we could be wrong about
certain levels remaining important in future sessions.

The table below summarizes our findings after examining different timeframes
and using different methods to identify potentially important levels for the
S&P 500 Index. Some of charts and data are as of Monday's close or before
Tuesday's intraday move to 1,261 (charts are dated). Levels with the greatest
probability of relevance are highlighted in green with white numerals. We believe
the strongest potential support exists near 1,256. Other key levels include
1,270, 1,225, and 1,190.

For those not familiar with technical analysis, there is no need to review
the charts below; they are presented for readers who want more confidence
in the levels shown in the summary table above. The concepts in the charts
below are summarized in the table above.

Unlike the other charts shown, the one below does include Tuesday's session.

The charts below are taken from a recent study we conducted focusing on short,
intermediate, and long-term support for stocks. The concept of support and
resistance speaks to the memory of market participants, and maybe more importantly
the computer-driven trading algorithms used by numerous hedge funds, pensions,
and mutual funds. Market levels that have been important in the past tend to
be important again when revisited in subsequent trading sessions.

Chris Ciovacco is the Chief Investment Officer for Ciovacco
Capital Management, LLC. More on the web at www.ciovaccocapital.com.

All material presented herein is believed to be reliable
but we cannot attest to its accuracy. Investment recommendations may change
and readers are urged to check with their investment counselors and tax advisors
before making any investment decisions. Opinions expressed in these reports
may change without prior notice. This memorandum is based on information available
to the public. No representation is made that it is accurate or complete. This
memorandum is not an offer to buy or sell or a solicitation of an offer to
buy or sell the securities mentioned. The investments discussed or recommended
in this report may be unsuitable for investors depending on their specific
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a guide to future performance. The price or value of the investments to which
this report relates, either directly or indirectly, may fall or rise against
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subject to change without notice. This information is based on hypothetical
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Ciovacco Capital Management, LLC is an independent money
management firm based in Atlanta, Georgia. CCM helps individual investors and
businesses, large & small; achieve improved investment results via research
and globally diversified investment portfolios. Since we are a fee-based firm,
our only objective is to help you protect and grow your assets. Our long-term,
theme-oriented, buy-and-hold approach allows for portfolio rebalancing from
time to time to adjust to new opportunities or changing market conditions.